Assume ABC Company has chosen to invest in new manufacturing equipment. The init

Question

Assume ABC Company has chosen to invest in new manufacturing equipment. The initial cost of the equipment is $1,200,000. The equipment has a useful life of 20 years. The company uses straight-line depreciation. Their tax rate is 30%. Their weighted average cost of capital is 10%. The new equipment is expected to increase net cash flows by $500,000 in year 1, $350,000 in years 2 through 4, and $100,000 in years 5 through 10. Using all four investment assessment methods (IRR, ARR, NPV, or payback), perform the calculations for this project. Based on just ONE of your calculations should the project be accepted or rejected? Critique the results of the other three calculations you completed. Do they all support your accept/reject decision? Which assessment method is the best?

Explanation / Answer

ABC Company Cost of Equipment           1,200,000 Useful life in years                       20 Yearly SL deprciation               60,000 NPV Calculation   Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Cost of Equipment       (1,200,000) Increased Cash inflows      500,000     350,000     350,000     350,000    100,000    100,000    100,000     100,000     100,000     100,000 Net Cash flows       (1,200,000)      500,000     350,000     350,000     350,000    100,000    100,000    100,000     100,000     100,000     100,000 PV factor @10%                          1           0.909          0.826          0.751          0.683        0.621         0.564         0.513          0.467          0.424          0.386 PV of Net Cash inflows =       (1,200,000)      454,545     289,256     262,960     239,055      62,092      56,447       51,316       46,651       42,410        38,554 NPV = $ 343,286.71 Payback period is Years = 3 Years ARR Calculation   Cost of Equipment           1,200,000 Book Value after 10 years             600,000 Average Investment =(120000+600000)/2=             900,000 Total Net Cash flow in 10 years=         2,150,000 Less depreciation for 10 years             600,000 Net Accounting Income for 10 years=         1,550,000 Average Accounting Income per year=             155,000 Accounting rate of return=155000/900000= 17.22% IRR Calculation   Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Cost of Equipment       (1,200,000) Increased Cash inflows      500,000     350,000     350,000     350,000    100,000    100,000    100,000     100,000     100,000     100,000 Net Cash flows       (1,200,000)      500,000     350,000     350,000     350,000    100,000    100,000    100,000     100,000     100,000     100,000 PV factor @19.691%                          1           0.835          0.698          0.583          0.487        0.407         0.340         0.284          0.237          0.198          0.166 PV of Net Cash inflows =       (1,200,000)      417,742     244,312     204,119     170,538      40,709      34,012       28,416       23,741       19,836        16,572 NPV = $             (1.02) So NPV at required rate 19.691% is 0. IRR =19.691% All the 4 paramaters , IRR , NPV, Payback,ARR indicate that the project can be accpeted. The NPV is positive, payback period is   very less. IRR and ARR are both way above the cost   of capital. We can accept the project on the basis of NPV alone , but even the other criteria are also supporting the acceptance of the project.

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